From Defined Benefit to Defined Contribution

State pension liabilities across the United States have surged to unprecedented levels in recent years. Historically, periods with higher levels of unfunded state pension liabilities have been associated with slower economic growth and restructuring of pension programs. Program restructuring takes many forms, and it ranges from benefit cuts to changes in eligibility requirements, to contribution rate increases—a more subtle form of restructuring involves adjusting the discount rate and actuarial assumptions built into defined pension benefit programs.

 Many different state pension reform proposals have been proposed in the academic literature, and some states have engaged in radical reforms that shift public pensions from defined benefit to hybrid or defined contribution plans. The common rationale for reform is that defined benefit plans are proving costly to taxpayers, and the costs cannot be carried forward during stagnant economic times. In addition to their high total costs—as evidenced by total contribution rates that exceed 20 percent per dollar in most public programs—defined benefit programs are less predictable when it comes to future funding costs and outlays.

Despite the need for state-level reform, defenders of defined benefit programs assert that the programs simply need tweaks to be sustained; proponents resist radical reform because they are concerned about capital flight and the transition costs associated with shifting from defined benefit plans.

This paper explores the current state of public pensions across the United States and addresses transition cost and capital flight concerns. Further, it examines defined benefit programs vis-à-vis defined contribution plans, using a number of case studies to illustrate the challenges many states face.